Air Canada/Onex Corporate Fist Fight Enters Round Two

In what must surely be one of the most important contested mergers in Canadian corporate history, Air Canada has struck back at Onex’s proposed acquisition and combination of Air Canada and Canadian Airlines into a single carrier (announced August 24). On October 19, Air Canada announced its counter proposal which constitutes a comprehensive restructuring of Canada’s airline industry, the main elements of which are as follows. Air Canada proposes to offer a substantial cash buy back to its shareholders, offer to buy and operate Canadian Airlines as a distinct brand entity, establish a new low-fare airline, and improve efficiencies by realigning surplus mainline and regional capacity. The proposed transactions are subject to regulatory approval where required. The transactions will be funded through a financial package totaling $930 million. As part of the package, Air Canada’s Star Alliance partners UAL Corporation and Deutsche Lufthansa AG, as well as the Canadian Imperial Bank of Commerce, will contribute up to $500 million of value to Air Canada. These investors, over time, could acquire a maximum of 10 per cent equity. The particulars of the proposed transaction are as follows.

Air Canada will launch an Issuer Bid, subject to the usual conditions, for up to 35 per cent of its outstanding shares or approximately 66 million shares. The price for the share buy back is $12 cash per share, which represents a premium of 28 per cent over the closing price on Friday, October 15, 1999. As a result, Air Canada shareholders will receive up to $800 million in cash.

Air Canada will offer $2 cash per share for a total of $92 million for all of the issued and outstanding voting and non-voting common shares of Canadian Airlines Corporation (approximately 46 million shares on a fully diluted basis). This represents a premium of 23 per cent over the closing price of Canadian’s shares on Friday, October 15, 1999.

The Takeover Bid Circular is expected to be mailed to shareholders of Canadian Airlines Corporation by early November. The offer will be subject to the usual conditions, including that a minimum of 50 per cent plus one of the outstanding Common Shares, on a fully diluted basis, are tendered. A key condition is that Canadian Airlines Corporation should be required to waive its shareholders’ rights plan (or the plan must be otherwise invalidated), and Air Canada shall be satisfied that American Airlines will not exercise, or will have been prevented from exercising, any exchange rights into Canadian Airlines Corporation shares.

Air Canada’s offer to acquire all of the issued and outstanding shares of Canadian Airlines shall be submitted by Air Canada for merger review by the Competition Bureau under the Competitiion Act for such other governmental or regulatory consents or approvals in Canada, the United States, or elsewhere as are required to conclude the acquisition.

Other important aspects of the proposed transaction are as follows. Air Canada and Canadian Airlines will not be merged. Canadian will become a subsidiary of Air Canada and through this subsidiary relationship Air Canada will be insulated from the risks associated with the indebtedness of Canadian Airlines. Canadian will retain a smaller head office in Calgary and will be led by a team of Canadian and Air Canada executives. There will be a net employment reduction of 2,500 at Canadian Airlines which will be accommodated largely through attrition and, if necessary, early retirement, alternative employment opportunities in voluntary severance packages. Air Canada requires that Canadian code share with Delta Airlines as well as United Airlines and Lufthansa and other Star Alliance partners. Canadian would be further required to negotiate the repatriation of commercial and operational management functions to Canada from AMR in the U.S.

The Air Canada $930 million financing package is structured as follows. Funds will be provided by UAL Corporation and Deutsche Lufthansa AG, two of Air Canada’s Star Alliance partners, and the CIBC, Air Canada’s Aeroplan partner which operates the Aerogold Visa program. Also participating in the financing is Bayerische Landesbank. UAL and Lufthansa will provide a total of approximately $420 million in liquidity to Air Canada, which will include a value contribution of up to $300 million. In addition, Air Canada, UAL and Lufthansa have committed to each other for a 10-year period.

UAL and Lufthansa have agreed to acquire a new series of perpetual convertible preferred shares in the amount of $230 million. The shares will only pay dividends if, as and when they are declared on the Common Shares. At the holders’ option, they will be convertible into Class A Non-Voting Common Shares at a conversion price in the range of $24-$28 per share. Additionally, UAL and Lufthansa will provide a 10-year credit guarantee facility to Air Canada of approximately $310 million. CIBC will provide a $200 million up-front payment to Air Canada. Air Canada will provide to CIBC approximately 4.4 million warrants exercisable for Class A Non-Voting Common Shares at $24-$28 per share over five years. Assuming conversion of the UAL-Lufthansa preferred shares and the exercise of the CIBC warrants, UAL and Lufthansa would together own approximately 7 per cent of Air Canada, while CIBC would own 3 per cent. The 90 per cent of the outstanding shares would remain in the hands of the current Air Canada shareholders. Air Canada is of the view that the financial structure is in compliance with the individual and non-resident ownership limits provided in the Air Canada Public Participation Act (Canada).

Stikeman, Elliott is acting for Air Canada. The Stikeman team is comprised of Calin Rovinescu (lead corporate and M&A), Jean-Marc Huot, Edward B. Claxton, John M. Stransman, Simon A. Romano and Margaret E. Grottenthaler on corporate and M&A matters; Louis P. Bélanger, R. Michel Décary, Q.C., Sean F. Dunphy and Eliot N. Kolers on litigation matters; and Lawson A.W. Hunter, Q.C., and Randall J. Hofley on competition and regulatory matters.

James C. Baillie, Q.C., of Tory Haythe is counsel to the Air Canada independent committee of directors.

Davies, Ward & Beck is acting for Onex.

Bennett Jones is acting for Canadian Airlines. The Bennett Jones team consists of John Gulak and John MacNeil, on handling the Arrangement Agreement with Onex and American Airlines with strategic input from Martin Lambert and H. Martin Kay; Patrick J. Brennan, Alan W. Rubin and David M. Lennox on financial instruments; Darcy D. Moch on tax; Debbie E. Bryden and Bryan C.G. Haynes on due diligence and disclosure; Bradley D. Markel on proxy matters; H. Martin Kay, Anthony L. Friend, Y. Beth Riley and Robyn M. Bell on court applications; Neil H. Stevenson and Christopher A. Brown on pensions and employment issues.

McCarthy Tétrault is acting for American Airlines. The McCarthy team consists of René R. Sorrell and David Armstrong on corporate matters, Lorne P. Salzman and Oliver Borgers on competition matters, Paul Steep and Eric Gertner on litigation matters. In the Montreal office of McCarthys Gérald Tremblay is responsible for litigation matters and in the Calgary office Bruce MacPhail is responsible for litigation matters.

Blake, Cassels & Graydon is acting for UAL Corporation and Deutsche Lufthansa AG. The Blake team consists of Alan Bell, Pamela Hughes, Warren Grover, Bill Mugford, Andrea Freund, Mario Josipovic and Daniel Bernstein (corporate/securities), Glenn Leslie (competition and litigation), Leslie Morgan and Kathleen Penny (tax), Greg Kanargelidis (international trade), Sam Principi (aircraft leasing) and Anne McNeely and Kathryn Podrebarac (litigation).